ECONOMIC THEORIES AND WORLD ECONOMY

11 January, 2019

Economics and Trade

“A QUIET AND MODEST LIFE BRINGS MORE JOY THAN A PURSUIT OF SUCCESS BOUND WITH CONSTANT UNREST”

EINSTEIN

 

Agree with the beautiful statement of Einstein. But the reality is, the entire world is continuously in motion either they are human beings, states or economies. But what they are struggling for? “THE SUCCESS” its economy, foreign policy or international trade etc. In the real world, everyone wants to get success to achieve his/her goals of life, so as the nations are. Here in this article I would like to explain and relate the different macroeconomic theories implemented for the success of the nations and also explain where the world economy is moving and which economic theory is beneficial for the development to gain success for a nation.

 

The Different Macro Economic Theories Are:

Different economist put their theories for the economical smooth running of a nation and to gain success. A Macroeconomic theory is a set of principles that describe how the key macroeconomic variables are determined. Every macroeconomic theory comes up with a set of policy recommendations that the government will follow. Various macroeconomic theories have been proposed: Classical Economics, Keynesian economics, monetarism, the new classical economics theories etc. All these theories are based, in varying degrees, on the classical economics that preceded the advent of Keynesian economics in the 1930s.

 

Classical Economics:

The macroeconomic theory that preceded the advent of Keynesian economics in the 1930s by Scottish Economist Adam Smith (1723-1790) has been widely known as the Classical Macroeconomics. Classical economists believed in free markets and that the economy would always achieve full employment by forces of demand and supply. So, if there were more people seeking work than the number of jobs available, wages would fall until all those seeking work are employed. Thus, the full employment of workers was guaranteed by market forces. For the market mechanism to work, the market structure had to be that of perfect competition, and wages and prices had to be fully flexible.

The classical economists didn’t involve government in markets. According to Classical Economists, there was no need for government intervention as market forces led to full employment equilibrium in the economy. Monetary policy would only have the impact on prices, neither it affects the important factors of output and employment. On the other hand, Fiscal policy (using government spending or taxes) was perceived to be harmful. For example, if the government borrowed to finance its spending, it would simply reduce the funds available for private consumption and investment, this phenomenon is known as crowd out Effect. Thus, the classical economists recommended use of neither monetary nor fiscal policy by the government. This policy recommendation is known as the Laissez-Faire policy. This Theory is also known as Classical Liberalism.

 

Keynesian Economics:

Keynesian economics was born during the Great Depression of the 1930s. The classical economists had argued that the self-adjusting market mechanism would restore full employment in the economy, should the economy deviate from the full employment path for some reason. The experience of the Great Depression, however, showed that the market forces did not work as well as the classical economists had believed. The unemployment rate in the United States rose to above 25 percent of the labor force. Hard-working people were out in the street looking for non-existing jobs. Wages fell substantially, but the lower wages did not re-establish full employment.

The English Economist John Maynard Keynes (1883-1946) argued that the self-adjusting market forces would take a long time to restore full employment. He predicted that an economy can be stuck at a high level of unemployment for a prolonged period.

According to Keynes, the government should find a way to increase aggregate demand. So Government should intervene in markets to resolve the issues of Economic Depression. For this purpose, one direct way is to increase government spending. For example, increased spending on a government project will generate jobs and incomes for the persons employed on the project. This, in turn, would provide demand for goods and services from private producers and generate additional employment in the private sector.

The Roosevelt administration implements the Keynesian policy and started various government programs aimed at boosting incomes and aggregate demand. As a result, the Keynesian policy leads to higher employment rate but also leads to higher inflation.

 

Monetarism:

Monetarism was an attempt by conservative economists to reestablish the wisdom of the classical laissez-faire recommendation. By 1950, Keynesian economics was well established. The monetarism birth took place in the 1960s. The original proponent of monetarism was Milton Friedman (1912—2006), now a Nobel Laureate. The monetarists argued that while it is not possible to have full employment of the labor force all the time, it is better to leave the economy to market forces. Friedman contended that the government's intervention leads to greater instability in the economy. He argued that while the economy would not achieve a state of bliss in the absence of government intervention, it would be far more tranquil.

Friedman modified some aspects of the classical theory. Monetarism supports that neither monetary nor fiscal policy should be used in an attempt to stabilize the economy and that the money supply should be allowed to grow at a constant rate. The monetarist policy recommendations are similar to those of the classical economists, even though the reasoning is somewhat different.

 

The New Classical Economics:

The 1970s saw a further push to revive the classical theory. The new classical economists provided a theoretical framework and empirical evidence to support the view that neither fiscal nor monetary policy can be effective in altering the output and employment levels in a systematic manner. The supporters of the new classical economics argued that if economic agents (consumers, businesses etc) used rational expectations (i.e., all available information) regarding government policies, they would frustrate any anticipated policy action by the government by altering their own behavior. Thus, there was no point in conducting monetary and fiscal policies, since market forces are not manageable to such manipulations.

Proponents of New Classical Economics have further built on the rational expectations concept and have developed "real business cycle models."

 

Business Cycle:

The business cycle, also known as the economic cycle or trade cycle, is the downward and upward movement of gross domestic product (GDP) around its long-term growth trend. The length of a business cycle is the period of time containing a single boom and contraction in sequence. These fluctuations typically involve shifts over time between periods of relatively rapid economic growth (expansions or booms), and periods of relative stagnation or decline (contractions or recessions). Business cycles are usually measured by considering the growth rate of real gross domestic product (RGDP).

The common or popular usage boom-and-bust cycle refers to fluctuations in which the expansion is rapid and the contraction is severe.

 

The Dominant Macroeconomic Theory:

While the existence of numerous macroeconomic theories is somewhat confusing, there is usually a dominant theory that the government follows. In the late 1990’s one can safely argue that the United States and many other capitalist countries largely follow Keynesian policy recommendations. In the current world most of the nation/ countries are following Keynes policy, but the question arises? Are the nations SUCCEEDED in achieving the goals of the individuals or economy? History shows that Keynesian policy is effective, but up to some extent, Keynes policy leads to higher employment rate but also leads to higher inflation.

 

Conclusion:

According to my opinion, nations should follow classical economics theory because in classical economics markets are free and this leads to full employment rate. It is obvious from above theories that Classical theory, New Classical Theory, business cycle fall in the same category following classical economic theory, free from government intervention but on the other side Keynes economic theory has its own importance but up to some extent. Further inflation rate is not rising because of free markets in classical theory. In free market mechanism, there is competition among entrepreneurs due to which there are less chances of high inflation rate. For this purpose, the government should not intervene in markets and should give a free hand to entrepreneurs & businesses so they can produce more and on fewer prices.

Take examples of nations with free market economy. According to 2018 Fraser Institute report Hong Kong has scored 90.2 which are the highest score in the world, on the second, Singapore takes place with a score of 88.8. These economies flourish and take their positions because of free markets. Because classical liberalism or classical economy covers all aspects like personal choices, rule of law, free markets, property rights, lack of political corruption. I am of the opinion that by implementing classical economics the entire nation prospers and they will SUCCEED in achieving their goals for their people and the economy. I conclude with the quote of Adam Smith, which I think would be beneficial for the individuals and the economy “That the Chance of Gain Is Naturally Over-Valued. We May Learn from the Universal Success of Lotteries” and I think there will be more peaceful life of individuals and sound economy with the implementation of classical economic theory in which there is no government intervention.